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Emerging Markets

Taking Asia’s credit

The world’s bond markets may have started to function again, but while Europe and the US are enjoying a boom of new deals, Asia’s borrowers have been finding themselves squeezed out

When the Republic of Indonesia sold dollar bonds to fund a widening budget deficit last June, it found investors keen to snap up 30-year bonds at a yield of just over 8%, and 10-year debt at less than 7.5%.

Already the markets had pushed Indonesia’s funding costs wider, following the collapse of Bear Stearns last March. But when the Republic returned in February this year, 10-year bonds cost 11.75%, and any hopes of selling long-dated, 30-year paper quickly went out of the window.

Indonesia went ahead and sold $2 billion of 10-year bonds, agreeing to hand over almost $90 million more in interest payments each year compared to the 10-year notes it sold last summer. It succeeded in funding its budget deficit, but an extra interest charge of close to $900 million over the duration of the bonds is no small burden for a country grappling with worsening economic conditions, falling exports and a high subsidy bill.

Indonesia has been Asia’s biggest sovereign borrower each year since 2006, and that reliance on international debt leaves it more exposed to the financial turmoil than many of its regional peers. It has seen its cost of funding ease slightly since March, as demonstrated by a new issue of $650 million of five-year Islamic bonds, priced to yield 8.8% on April 16. But its experience mirrors a situation faced by governments and corporate treasuries across Asia, who are struggling to raise cost-effective capital despite a boom in new debt sales in the US and Europe.

“Asia is catching up, but it’s a surprise that we haven’t seen more supply here, given that the markets have been open since the start of the year,” says Stephen Williams, head of global capital markets for Asia Pacific at HSBC in Hong Kong. “Some companies were aggressive in pre-funding early last year, but in some cases Asian borrowers were slow to realize the severity of the crisis. By the time they did, the markets were already shut.”

The international debt markets slammed shut for Asian issuers with the collapse of Lehman Brothers in September, as global fund managers fled from emerging market risk and the hedge fund industry went into meltdown. No Asian borrower – private sector or public – was able to access the global bond markets until January, and it took until late March for the first private-sector Asian company to sell dollar bonds.

At the time of writing, Asian borrowers outside of Japan and Australia had sold bonds worth just $19 billion since the start of the year – compared to $790 billion in Europe and $708 billion in North America.

Conditions have eased since the height of the credit crisis in the fourth quarter of 2008, but it remains impossible for many lower-rated Asian borrowers to sell bonds without government support, and those that still have the ability to access the international debt markets are finding it an expensive exercise.

Investor base narrows

The international investors who have stayed committed to Asian credit have picked up some bargains over the last few months. Bonds sold by the Republic of the Philippines in January had soared to more than 111% of face value by late April, while debt issued by Korea Development Bank and Export-Import Bank of Korea in January quickly jumped to 104%.

Rising prices show that investors are returning to the Asian market, but the range of buyers has narrowed dramatically from just six months ago. The US hedge funds that bought into high-yield Asian debt in the heady days of 2006 and 2007 have all but disappeared, in many cases after heavy losses, while the structured investment vehicles and conduits that were regular buyers of investment-grade and public-sector Asian paper live on only in the history books.

German public-sector lender Depfa, which had invested hundreds of millions of dollars a year on South Korean bonds, shut its Hong Kong office in March, while European lender Dexia – another big buyer of Korean bonds – has scaled back its Asian investments dramatically.

Few banks run proprietary trading desks on a scale approaching that of 12 months ago, while many of the bank investors have been forced to wind down their Asian investments altogether after taking government bail-outs. RBS is in talks to sell its Asian business just a year after acquiring ABN Amro, while UBS’s principal trading arm was one of the first casualties of the subprime crisis. Lehman Brothers’ in-house trading desk was a big buyer of high-yield Asian credit until its collapse, while JP Morgan and Barclays Capital – formerly big investors in Asian debt – have scaled back their positions. Dresdner Kleinwort, which had been a big investor in subordinated bonds sold by Asian banks, and UniCredit’s HVB, another big buyer of Asian debt in recent years, have also pulled back.

Asian investors are taking much bigger allocations in new issues, and it is the insurance companies and long-term emerging funds that are the most active – again a big shift from early 2008.

“The old-fashioned real money has come back with a vengeance,” says Herman van den Wall Bake, head of international debt syndicate for Asia at Deutsche Bank in Singapore. “The investor composition was already changing last year, but Lehman’s collapse was the tipping point. The European conduits disappeared, and a lot of the Asian hedge funds went out of business. Pension funds, insurance companies and the traditional money managers have been the big buyers in 2009.”

Buyers are concentrated on new issues, while trading Asian debt in the secondary markets can be difficult. “There are simply fewer people involved in secondary trading now,” says Joel Kim, head of fixed income for Asia at ING Investment Management in Hong Kong. “The banks that used to act as market makers don't have the balance sheet to do so anymore, and bid-offer spreads are still quite wide across the market, regardless of the credit.”

Default fears

Many of the Asian companies who sold dollar bonds over the past two years are now restructuring candidates, and concerns over rising corporate default rates mean bankers expect sub-investment grade companies will remain shut out of the international markets for some time to come.

Asia Aluminum, a Chinese aluminium producer which was privatized in a management buy-out in 2007, appointed provisional liquidators in March after foreign bondholders blocked its attempts to restructure $1.2 billion of offshore debt, paving the way for the biggest test of creditors’ rights yet under China’s two-year-old bankruptcy laws.

Bondholders said Asia Aluminum’s restructuring proposal, which would have forced them to take a haircut of more than 75% on the face value of the bonds, favoured domestic lenders, and the ongoing negotiations are being closely watched as a gauge of potential recovery rates on the many other international bonds sold by Chinese companies under similar structures. Any sign of prejudice will severely dent investors’ confidence, making it harder and more expensive for Chinese companies to raise international capital in the future.

“The Asia Aluminum debacle raises significant questions over the way these deals have been structured and the protection foreign investors can expect,” says Bake at Deutsche Bank. “Investors can have short memories if they think they can make a few dollars, but we’re not anywhere near a point where Asian high-yield deals can be done regularly.”

Chinese companies, including those listed in Hong Kong, have sold high-yield bonds worth $20.9 billion since 1997, according to data firm Dealogic. Many of those issued in the boom years of 2004 to 2007 have been downgraded in recent months as earnings have deteriorated, including bonds from property developers Neo-China and Greentown China, as well as China Orienwise, a consumer finance company.

Green shoots

There are signs, however, that international money is returning to Asian credit. Currencies such as the Korean won, which was among the worst hit by the retreat from emerging market risk at the end of 2008, have posted some gains since the start of the year, while stock markets in Hong Kong and China rallied strongly in March and April.

Falling credit spreads have attracted well-known and respected names such as Korea’s Posco and Hong Kong benchmark Hutchison Whampoa to tap dollar bonds for long-term funding, and bankers are expecting many more to follow. “There has been a lot of interest in the recent corporate transactions, and we think other Asian companies will follow,” says Williams at HSBC. “We expect there to be more supply from blue-chip corporates in the next few months.”

Posco attracted orders worth $4 billion for its $700 million, five-year bond, launched on March 20, in a deal that was carried away on the biggest one-day rally in US Treasuries for years, after the Federal Reserve announced a plan to begin quantitative easing. The rally helped Posco tighten price guidance twice in two days of marketing, eventually pricing the notes to yield 8.95% in the first international bond issue from any privately-owned Asian company since early September.

Hutchison, Asia’s best-known corporate bond issuer, sold $1.5 billion of new 10-year bonds on April 7, locking in long-term funding at a cost of around 7.67% after a rally in credit spreads brought down its cost of capital.

Demand for new bonds helped the Republic of Korea sell $3 billion of five- and 10-year debt on April 8, after Hana Bank sold the first dollar bonds guaranteed by the Korean government a week earlier. Both of those new issues were popular with investors, giving an indication that appetite for Asian risk is returning fast.

“It is clear that not every Asian issuer is able to access the international markets, but sovereign-linked borrowers and a select number of good-quality corporates can get deals done,” says Kim at ING. “It’s just a matter of paying up.”

Indonesia watched yields on its 10.375% bonds due 2014 dip below 8% in late April as appetite for emerging market debt continued to return, helping the government raise another $650 million in its first global sale of Islamic bonds.

But credit spreads remain many times wider than their pre-crisis levels, and the wild price swings of the last six months have served as a painful reminder for Asian borrowers of their dependence on investors far away in New York or San Francisco. In the debt markets at least, Asia is still playing catch-up.

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